Trade in Financial Services



Trade in Financial Services

John B. Taylor

Under Secretary of Treasury for International Affairs

Testimony before the

House Small Business Committee

October 24, 2001

Thank you, Chairman Manzullo, Ranking Member Velazquez, and members of the Committee for inviting me to participate in this hearing on "Trade in Services."

I would like to focus my opening remarks today on international trade in financial services. Financial services-from banking to pension fund management to insurance-represent one of the most exciting and dynamic sectors of the economy. Consumers take for granted the convenience of ATMs, online banking and bill payment, and a host of other innovations that make financial transactions cheaper and less time-consuming. Businesses today rely on an increasingly sophisticated range of financial products to hedge risk, provide for greater stability in their operations, and make their services more competitive.

The benefits that Americans enjoy in this arena are the result of the innovation and development of the U.S. financial services sector, which has played an important role in making our entire economy one of the most competitive in the world. Small- and medium-sized businesses have benefited from developments in the financial services sector, particularly the increased variety of insurance and retirement-savings vehicles that are now available to small businesses. Greater trade in financial services will offer even more significant benefits to American consumers and businesses.

Benefits to Americans of Trade in Financial Services

U.S. firms are preeminent worldwide in the field of financial services. Securities firms like Goldman Sachs and Morgan Stanley, banks such as Citigroup and Wells Fargo, and insurance companies such as Aetna and Prudential have become truly global institutions.

The U.S. financial services market is highly diverse and competitive, encompassing more than 5,000 broker dealers, 9,000 banks, and 8,000 insurers. Many of these are local financial institutions, such as Home State Bank and Franklin Life Insurance Company which service the businesses and consumers of Northern Illinois. Small- and medium-sized financial institutions continue to play an essential role in the economy.

In 2000, U.S. cross-border exports of financial services -- banking, securities, and insurance -- totaled $19.5 billion, while cross-border imports of financial services were $13.7 billion (these figures do not include intra-firm transactions). The overwhelming majority of financial services provided by U.S.-owned firms to clients in other countries (and by foreign-affiliated firms to clients in the United States) are not cross-border transactions, but rather are furnished by branches and subsidiaries of U.S. firms established in host countries (and foreign branches and subsidiaries in the United States). In 1998, affiliates of foreign firms in the United States provided some $75 billion in financial services, and affiliates of U.S. firms abroad provided $47.2 billion in insurance alone.

Improving the access of U.S. financial institutions to foreign markets helps our exporters continue to expand and develop new markets, building upon the American competitive advantage in the provision of these services. Liberalizing trade in financial services on a multilateral basis through the World Trade Organization (WTO) can help small- and medium-sized financial institutions, many of which do not have special access arrangements with foreign countries, to enter foreign markets. With the advent of internet banking and online trading, smaller U.S. businesses that cannot afford to set up a foreign office can provide individuals living in other countries with advanced financial services that American consumers enjoy.

Liberalizing trade in financial services also benefits U.S. consumers and businesses outside of the financial sector, particularly small businesses. While America is generally seen as the leading exporter of financial services worldwide, it also is a significant importer of financial services from other countries, notably in insurance. Numerous foreign financial institutions and foreign capital have played a vital role in the development of the world's most competitive and largest capital market.

Americans benefit in several ways from the increased competition, innovation, and productivity that result from the increased supply of foreign financial services.

First, American consumers benefit from the latest and most innovative financial products, which in part is due to the competition provided by foreign providers. For instance, American investors in the last decade have seen an explosion of new types of annuities, mutual funds, and bond or equity derivatives to increase their savings and investment potential, many of which are organized or managed by foreign-affiliated entities or based on foreign securities.

Second, another benefit is the lowered costs of financial services in the United States. Today, the United States has one of the most open, transparent financial markets in the world, supported by prudent financial sector legislation and strong regulation. Over half of the investment banks to which U.S. Treasuries are sold ("primary dealers") are foreign-owned. This competition yields internationally low costs, which enables U.S. firms to make the investments needed to expand the productive capacity of the U.S. economy.

Benefits to Emerging Markets and Developing Countries of Trade in Financial Services

In emerging markets and developing countries, liberalization of a country's external trade regime in financial services is integrally related to its domestic financial sector liberalization and the openness of its capital account. And, as we all know, the costs of poorly managed liberalization can be high. I would like to review some lessons of recent financial crises and the change that is evolving in the international community's approach to financial sector management.

Foreign participation contributes to financial system strengthening, particularly in emerging market economies. For example, entry of U.S. banks into emerging market countries is accompanied by an array of tangible and intangible benefits for the local banking sector. Particularly significant are the capital funds that a subsidiary bank brings with it upon entry into the foreign market, which can be especially welcome in the case of acquisitions of distressed institutions, such as in Mexico, Korea, Thailand, the Czech Republic, Hungary and Poland.

Among the intangible benefits are the introduction of new technology and products, improvements in training and the transfer of skills, and improvements in market practices and infrastructure. Examples of services which U.S. financial firms could introduce into foreign markets are innumerable, but include auto financing and health insurance to China, financial leasing and charge cards to Russia, to name a few. Foreign participation also introduces a higher degree of competition, which usually leads to lower prices, better quality services, and more competitive financial institutions.

Of critical importance, foreign banks can increase stability in emerging market banking sectors, as well. Using their global experience, technological advances, and well-trained management, foreign banks are able to import advanced credit risk management practices. To respond to the volatility of interest and exchange rates, global banks have developed highly technical models and techniques to measure value-at-risk and associated products, such as hedges and interest rate swaps. Moreover, foreign offices of U.S. banks are subject to U.S. supervision and standards of practice. As a result, local regulatory authorities and domestic banks are exposed to the exacting standards of our regime through contact with these offices.

Foreign banks in developing countries have stronger credit growth, more aggressive provisioning for potential losses, and higher loss-absorption capabilities. Domestic banks often adopt the advanced credit risk practices of their new competitors, and domestic regulators face pressure to adopt international standards to regulate the new market entrants. All of these effects of foreign bank ownership impart important stabilizing influences on domestic banking systems in emerging markets. Foreign participation helps strengthen, and make more stable, a country's financial services sector.

A recent WTO study of 27 emerging market countries found that allowing foreign financial institutions to establish locally and engage in a broad spectrum of financial activities contributed to greater financial sector stability. For banks in particular, a recent study of financial crises in emerging markets in Latin America showed that during periods of crisis, foreign banks established in those countries actually increased their local lending relative to domestically-owned institutions. This is aided by such institutions having an international capital base and not having concentrated pre-crisis lending to the country involved, unlike domestic institutions in the affected countries.

These lessons have not been lost on the countries that underwent crisis -- such as Mexico, Korea, Indonesia, Thailand, and Brazil -- which have, as part of their adjustment efforts, either accelerated liberalization of market access in their financial services sector or openly sought the entrance of foreign service suppliers to their market. An internationally open system does not mean an unsupervised one. Robust prudential supervision is indispensable for maintaining financial sector stability. This has been enshrined in the GATS framework, which grants WTO members wide discretion to adopt measures necessary to preserve financial sector stability and integrity and to protect consumers and investors.

Status of Financial Services Negotiations

In 1997, for the first time, a broad group of countries (now 107), including the most important financial markets, made commitments to guarantee a certain level of market access and national treatment to foreign financial service suppliers in the WTO. By binding their markets open in a trade agreement, countries increased predictability and reduced risks for foreign and domestic providers alike.

It is fair to say that the 1997 WTO agreement primarily stabilized market access, in some countries at relatively low levels, rather than liberalizing it. Therefore, by prior agreement, new negotiations were started in the WTO in 2000. It is important for countries with significant barriers in place to make commitments that go beyond current practice, unlike the last round where the current levels of liberalization were the ceiling and not the floor for almost all scheduled commitments.

As part of that process, the U.S. submitted an initial financial services proposal last December in which we stated our expectations for negotiations concerning (1) core market access commitments (e.g., openness to foreign investment in all subsectors) to be adopted by all WTO members and (2) a set of transparency principles for regulation (e.g., prior notice and comment, time limits for decisions on license applications).

The U.S. market access proposals are important to help our exporters continue to expand and develop new markets. This is particularly true for the small- and medium-sized businesses that do not have special access arrangements with foreign countries. Some examples of our market access proposals are:

Countries should remove restrictions on a foreign supplier's ability to establish a local presence in its preferred legal form (i.e. subsidiary, branch, joint-venture, etc.). For example, foreign equity participation is currently subject to ceilings in the Philippines, Malaysia, Thailand and India, while legal structure is limited in Malaysia, Pakistan and Romania.

Countries should remove prohibitions on their residents consuming financial services abroad: this will become increasingly important as e-commerce develops in the financial sector. With the advent of internet banking and online trading, it is now possible for U.S. businesses, especially smaller ones that can not afford to set up a foreign office, to extend financial services to individuals living in other countries.

Transparency principles are critically important in the financial services sector. Even with access to a foreign market, almost all of the barriers to trade in financial services are contained in domestic regulations. Given the existence of the GATS prudential measures clause, one key way to eliminate barriers in the financial sector is to ensure that financial regulators use best practices in the development and application of regulations. We also believe that transparency is particularly important for small- and medium-sized firms seeking to do business abroad because they typically do not have the resources to navigate opaque regimes.

Some principles for the development of regulations include: make proposed regulations publicly available with a written explanation of their purpose, establish procedures for receiving public comments in a reasonable period of time, create a workable mechanism to respond to those comments, and, unless in the case of an emergency, allow a reasonable period of time for companies to begin compliance.

Once the regulations are developed, countries should establish transparent procedures for the application of regulations. Some of these principles include: make all regulations publicly available at a reasonable cost, establish in writing the activities for which a license is required and make public all procedures and criteria for applications, provide applicants with reasons for the denial of an application and allow for resubmission where feasible, and allow for a reasonable period of time and set of rules for examinations.

These best practices in regulation are vitally important for foreign service providers that are not as familiar with the domestic rules and procedures in all of the many countries that they could potentially utilize as an export market.

In addition to multilateral talks in the WTO, we also have ongoing negotiations of free trade agreements (Chile, Singapore and FTAA), in which we hope to obtain state-of-the-art financial services provisions due to the sophistication of these trading partners. For example, we are examining a broad concept of national treatment and the use of so-called "negative listing" of exceptions, which introduces a bias against restrictions by requiring a country to specifically identify each one. These could enhance bilateral and regional trade, be used as a model for other trade agreements, and ultimately provide impetus to multilateral negotiations.

To sum up, both the United States and other countries benefit greatly from liberalization in trade in financial services.

The Importance of Trade Promotion Authority

The U.S. government could more effectively negotiate the opening of foreign financial services markets, and achieve our other objectives in all of these forums, once it has new Trade Promotion Authority.

Trade Promotion Authority (TPA) will give the President the tools he needs to negotiate new trade agreements. These agreements -- which offer the same benefits as a tax cut -- will increase growth in the United States and the world. It will assure that the United States is not left behind as the European Union and others negotiate more liberal market access for themselves.

Trade is important to the U.S. economy. Recent studies predict that new trade agreements will significantly boost economic growth. The IMF and World Bank estimate that reducing tariffs in a new global trade round will generate global benefits of $250 billion to $550 billion per year. Another study estimates that cutting global trade barriers to goods and services by one-third would result in global gains of $613 billion, including U.S. gains of $177 billion per year. This amounts to $2,500 per year for the typical American family. Bilateral and regional free trade agreements (FTAs) also offer significant benefits -- an agreement on the Free Trade Area of the Americas would increase U.S. GDP by an estimated $53 billion, or about $800 per year for the typical American family. Small- and medium-sized enterprises will share in these benefits as they turn more and more to export markets.

The U.S. economy has benefited tremendously from trade liberalization in the past and it stands to benefit even more in the future. If the United States is to remain a leader in the global economy, it must also be a leader in global trade. To assure our leadership, Congress needs to pass TPA.

As President Bush said earlier this month, "We must keep on the path of economic progress. That progress begins with freer trade. Trade is the engine of economic advancement. On every continent, in every culture, trade generates opportunity and enhances entrepreneur growth. And trade applies the power of markets to the needs of the poor. It has lifted countless lives in all regions, from Asia to Australia to the Americas."

Mr. Chairman, those sentiments are exactly right. Thank you for inviting me to testify here today, and with that I would be glad to take your questions.

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